Derivatives

What is option writing

Gurumurthy K | | Updated on: Dec 04, 2021
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Short selling in the options segment is termed as ‘option writing’. That is writing an option means either you sell a call option or sell a put option. How does it differ from buying a call/put option?

Firstly, when you buy an option, the option premium is the only outflow that a participant will incur. Whereas in case of selling an option (writing option), the participant does not pay any premium. Instead, the seller receives the premium from the option buyer. When you buy an option, there is no margin money required. But when you sell an option, margin money will have to be paid upfront at the time of taking the position. So, there is a risk of getting a margin call to pay additional money in case if your position runs into a loss and your account runs out of balance.

Another major risk involved while selling an option is that the loss incurred could be unlimited. This is just opposite to that of buying an option where the loss is limited to extent of the premium paid. For example, assume that Nifty Bank Call option premium is ₹120 for a strike price of 38,000. A trader selling a call option will receive ₹3,000 (₹120*25 – the lot size) from the buyer. Say at the time of expiry, the Nifty Bank moves up to 38,500 and the premium moves up to ₹500. The seller of the option will have to buy back the option by paying ₹12,500. Thereby the option writer will incur a net loss of ₹9,500 (₹12,500 minus ₹3000 – the option premium earned) in this transaction. The more the Nifty Bank index moves up above the strike price, the wider the loss will be.

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Published on December 04, 2021

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